Friday, July 15, 2016

There’s been something very interesting happening with dividend focused stocks and it’s almost been happening by stealth.

Regular readers will know that I started a dividend growth focused accumulation portfolio almost 2 years ago. The portfolio is also known as ‘My 30 stocks for 30 years’ and features 30 dividend companies of varying yield and dividend growth rates but with an overall focus on long-term performance .

I have constructed this portfolio via a motif account, which allows for consistent accumulation at a low price. While the dividend portfolio skews to more moderate yield rather than high-yield, the blended yield of the overall portfolio is greater than that of the S&P 500 and comes in at roughly 2.3%.

The remarkable thing about this portfolio is that it hasn’t just beaten the S&P 500 in terms of just dividend yield alone or dividend growth alone. Rather the total return performance of this portfolio has been pretty mind blowing. In the roughly 20 months since inception the dividend growth accumulation portfolio has returned close to 14% compared to the S&P 500’s performance of roughly 5%. So in fact the portfolios performance has almost tripled that of the S&P 500.

You may be thinking that that’s because I have a bunch of exotic names in my dividend growth portfolio that aren’t commonly found in the S&P. In fact nothing could be further from the truth. It’s really vanilla garden-variety names that have accounted for much of this performance. Consumer staples businesses such as McCormick, Clorox, Johnson & Johnson Church and Dwight and Hershey’s have all rocketed in excess of 20% during the period of performance. In fact even businesses like GE and Verizon have had strong returns and are up high double digits as well.
This is particularly staggering when you consider that the supposedly high growth performers like Apple, Celgene, Baidu and others that have actually gone backwards over the same period of time.

I think part of the reason for the outperformance of staples is the general level of uncertainty in the economy. While US economic growth has been steady it’s been patchy and somewhat uncertain. That’s been reflected in respect of higher index volatility in the last 12 months and has seen periodic “flights to safety” toward the steadier, more consistent names.
The other major reason for the outperformance of consumer staples I believe comes down to expectations. Some of these supposedly high-growth businesses have taken a tumble and haven’t been able to meet market expectations. This has caused the PEs of growth companies to dramatically contract in some cases.

So if dividend stocks have been performing so well then arguably this no real reason to have a growth portfolio correct ? I would beg to differ on this point. This flight to safety has been so strong that consumer staples businesses have had their valuations skyrocket. Many of these names that will only have single digit growth are now trading at PEs well over 20. Conversely some of these higher growth names have had their valuation multiples compressed and are now trading at attractive valuations. I really can’t fathom why businesses such as Celgene currently trade at the levels they do.

Economic growth has also been artificially propped up by an extended low interest-rate environment. When we eventually revert back to the mean and when interest rates rise, more mature dividend growth companies are going to find juicing that growth all that more difficult.
Acquisitions will become more expensive. Expansion of product lines and financing will also become more expensive. That’s when I believe that companies which are riding a paradigm of strong organic growth will really shine. It’s my belief that over the next decade these growth businesses will outperform their slower growth dividend counterparts as growth becomes more difficult and expensive to come by.

That being said, I believe there’s a place in every portfolio for steady growing businesses that pay dividends and that have modest expectations, because time and again history shows that these businesses are able to exceed these modest expectations and deliver strong share price appreciation.

Conversely when growth conditions become tougher and there is an absence of conditions to stimulate growth, companies that have organic growth tailwinds at their backs can often keep growing irrespective of the economic environment.

It’s for these reasons that I’m happy to maintain both a dividend growth accumulation portfolio as well as a more growth oriented portfolio in addition to my core investments in the S&P 500